European Carbon May Decline to Record as Glut Expands

The region’s emissions trading system, or the EU ETS, imposes pollution caps on about 12,000 installations owned by manufacturers and power plants. Photographer: Wolfgang von Brauchitsch/Bloomberg

Jan. 9 (Bloomberg) -- European Union emission permits are
poised to drop to a record in the first half as member states in
the world’s largest carbon market fail to diminish the biggest-ever glut.

Allowances will fall below the record 5.93 euros ($7.75) a
metric ton reached last month, according to all nine analysts
surveyed by Bloomberg News. That implies a decline of at least
8.3 percent from yesterday’s closing price. The surplus may rise
18 percent this year, according to Bloomberg New Energy Finance.

The EU’s regulatory arm last year proposed to delay the
sale of some permits in a process known as backloading to boost
prices and shrink supply. A failure to tackle the glut may
discourage utilities from switching to natural gas and other
less-polluting energy sources from coal, the 27-nation bloc said
in a November report. That may curb investment needed in non-fossil fuel generation, estimated by New Energy Finance at about
400 billion euros, to meet the EU’s 2020 climate targets.

“Given the backloading may not commence earlier than in
the fourth quarter, 2013 could, at best, be a year of
stagnation,” said Matthew Gray, a Jefferies Group Inc. analyst
in London who has tracked the market since 2008. “At worst, the
proposal will fail and prices will collapse, potentially to 3
euros.”

EU carbon for delivery in December fell 4 percent to close
at 6.21 euros a ton on the ICE Futures Europe exchange in London
today, taking this year’s decline to 6.9 percent after a 16
percent drop in 2012. By comparison, Brent crude oil has gained
0.3 percent this year and rose 3.5 percent last year on ICE.

12,000 Installations

The region’s emissions trading system, or the EU ETS,
imposes pollution caps on about 12,000 installations owned by
manufacturers and power plants. The limits on discharges were
set before the euro area entered two recessions in four years.
The bloc’s regulator has little room to prevent a decline in
prices because there is no mechanism for cutting supply.

Companies will need to buy almost half the permits in the
system starting this month. In previous years they got most of
them for free and had to buy extra if needed.

Delays in auctions would amount to market manipulation,
Poland’s Environment Minister Marcin Korolec said in April. The
measure will cut income from sales of permits in Cyprus, Poland,
Estonia, Czech Republic, Bulgaria and Romania by about 1.9
billion euros in 2013 to 2020, his ministry said last month.

“There is a great deal of uncertainty whether the
backloading proposal will achieve the necessary support from
member states,” said Kathrin Goretzki, an analyst at UniCredit
SpA in Munich who predicts prices will fall to 5 euros by June
30. “Given the large amount of allowances to be auctioned in
2013, we expect that prices will remain depressed.”

Clarity Needed

The EU plan to sell fewer permits in the three years
through 2015 will probably be delayed until next year, according
to UniCredit. UBS AG, Switzerland’s biggest bank, said EU
nations will probably discuss the plan for a year and then
abandon it next year. The company forecasts prices from 5 euros
to 7 euros in 2013. Barclays Plc, based in London, said there’s
a 50 percent chance of it passing.

Connie Hedegaard, the bloc’s climate-action commissioner,
said in November that the carbon market needed clarity on the
backloading plan in 2012. Several member states were undecided
at a meeting in December about whether they would back the
measure, an EU official, who declined to be identified by name,
said at the time. European governments may formally vote on the
strategy in March at the earliest, the official said.

“We are very confident that governments understand the
positive impacts of backloading and will therefore support it,”
Isaac Valero-Ladron, a climate spokesman for the commission,
said yesterday by e-mail.

‘Lost Decade’

The commission would like to have the draft measure
approved as early as possible to improve the functioning of the
market, ensure higher state budget revenue from carbon auctions
and provide prices high enough to drive low emissions
technology, Valero-Ladron said. Proposals considered in this
type of legislative procedure usually need four to five months
to enter into force after a vote by member states.

Germany and the U.K. are among nations still undecided on
whether to vote in favor of backloading. The two countries
together hold almost 17 percent of total votes in the EU ballot
system, meaning their support may be needed to avoid deadlock. A
fix may boost the appeal of investing in cleaner sources of
energy than coal, such as nuclear and natural gas. EON SE is
among utilities considering whether to close gas-fed plants
while Electricite de France SA is among companies studying the
construction of new reactors.

“It’s beginning to feel like we’re in a lost decade in
terms of mobilizing private investment for emissions-reduction
projects,” said Trevor Sikorski, an analyst at Barclays in
London who expects prices to average 7 euros or less this year.
“The price signal shows we’ve overinvested.”

Financial Crisis

EU allowances for delivery this year extended their loss to
77 percent since they started trading in 2008. The excess of
permits rose to 1.1 billion tons at the end of last year, or
almost 50 percent of the bloc’s annual pollution limit,
according to New Energy Finance. The EU market began in 2005.

The 17-nation euro area’s economy will contract 0.6 percent
this quarter and 0.2 percent in the three months through June,
according to the median of 25 economists surveyed by Bloomberg.

The value of transactions in the global carbon market
dropped 36 percent last year to 61 billion euros, as prices
decreased, New Energy said Jan. 3. Australia introduced
compulsory carbon pricing on July 1. California’s market began
this month, boosting 2013 trading.

The EU’s estimated surplus may swell to 1.3 billion tons
this year without backloading, said Konrad Hanschmidt, an
analyst at New Energy Finance in London.

EU Ballot

The EU commission needs 255 out of 345 votes from member
states and approval from the region’s parliament to tackle the
glut. In the EU ballot system, which favors larger countries,
the U.K. and Germany each have 29 votes. Poland, which leads the
opponents of backloading, has 27.

“Backloading will never be agreed,” said Daniel Rossetto,
the managing director of Climate Mundial Ltd., a London-based
consulting company that works in carbon markets. “Lawmakers and
market participants will realize that backloading does not offer
the ‘once-only’ intervention that is desired. If implemented, it
would seriously impact confidence levels in the scheme itself.”

The commission, which sees auction delays as a short-term
measure to fix the market, has already started a debate on long-term options to strengthen the ETS.

‘Original Sin’

In a report presented to governments in November the
regulator set out tighter emission limits and cancellation of
carbon permits as well as mechanisms to support prices and
restrict imported offset credits as potential scenarios to
improve the market.

The best way to fix the market is to tighten emission-reduction targets, Mazzoni said. With climate slipping down the
global policy agenda, increased supply of permits at auctions
and backloading unlikely to happen “anytime soon,” carbon
prices may fall as low as 4 euros a ton, he said.

“The original sin lies in the lack of flexibility the
system has in terms of supply-demand balance,” Mazzoni said.

Offset credits in the United Nation’s Clean Development
Mechanism have also plunged. Credits for delivery this year
settled yesterday at 43 euro cents, down almost 90 percent in
the last six months.